BANK BAILOUT MAY HURT TAXPAYERS, BE OPEN TO FRAUD

April 21, 2009

Taxpayers are increasingly exposed to losses and the government is more vulnerable to fraud under Obama administration initiatives that have created a federal bank bailout program of "unprecedented scope," a government report finds. In a 250-page quarterly report to Congress that examines the six-month old, $700 billion Troubled Asset Relief Program, the rescue program's special inspector general concludes that a private-public partnership designed to rid financial institutions of their "toxic assets" is tilted in favor of private investors and creates "potential unfairness to the taxpayer."

Inspector General Neil Barofksy offers a series of recommendations to protect the public and takes the Treasury to task for not implementing previous advice. The report also commends Treasury and the Federal Reserve for creating some safeguards.

Overall, the report says:

The public-private partnership -- using Treasury, Federal Reserve and private investor money -- could total $2 trillion; the financial markets responded positively to the program when the Obama administration announced it last month, but the administration is still putting final touches on its implementation.

The sheer size of the program is so large and the leverage being provided to the private equity participants so beneficial, that the taxpayer risk is many times that of the private parties, thereby potentially skewing the economic incentives.

In particular, the report cited the private-public partnership that would purchase troubled real estate-related securities from financial institutions:

Under plans unveiled by Treasury, for every $1 of private investment, Treasury would invest $1 and could provide another dollar in a nonrecourse loan.

That money could then leverage a loan from another government fund backed mostly by the Federal Reserve, a step that Barofksy says would dilute the incentive for private fund managers to exercise due diligence.

Among Barofksy's recommendations:

Treasury should set tough conflict of interest rules on public-private fund managers to prevent investment decisions that benefit them at taxpayer expense.

Treasury should disclose the owners of all private equity stakes in a public-private fund.

Fund mangers should have "investor-screening" procedures to prevent asset purchase transactions from being used for money laundering.